Consider this financial statement of a company…
If I were a promoter of this company and asked you to invest your money in it – and you did not know me personally – would you invest?
Okay, to sweeten the deal, I lower my asking price by 10%, would you invest now?
I share with you my optimistic view on the company’s future, and how you are going to earn great returns in the future. But would you still budge?
“Okay, what are you going to do with my money?” you ask me.
I say, “I’ll use around 80% of the money you give me to retire a part of my loan.”
“80% just to retire loan!” you wonder. “How much total loan do you have?”
“Just Rs 1,200 crore.”
“Rs 1,200 crore! And how much more would you have after you repay the loan using money from me and other shareholders?”
“I would still owe my banks Rs 900 crore!”
“Oh! 80% of shareholders money to retire less than 30% of your loan! How do you plan to repay the rest?”
“I will consider other alternatives in the future?”
“This sounds risky!”
“Yeah, but look at our awesome future!”
“Okay, but at Rs 900 crore of future debt, and assuming a 10% interest rate, you would still have to pay Rs 90 crore interest every year. Your current annual revenue is just Rs 100 crore and you are deep into losses!”
“Yeah, but the future is bright!”
“The future is always bright, but how do I price that future into your asking price?”
“But I’m asking for just Rs 200 per share!”
“But that values your company at Rs 1,600 crore given your shares outstanding of 8 crore?”
“True, but Rs 1,600 crore is not much given the bright future!”
“Maybe! But if I were to value you at even 25x P/E, which I will pay for a well-run business with a reasonably good history, it would mean that you must show me Rs 64 crore in net profit right away, i.e., Rs 1,600 crore divided by 25x P/E.”
“That profit would come soon. You see, out future is bright!”
“But how soon? Even if you earn, say, a 15% net profit margin, which is also a reasonably good assumption, it means you must earn revenue of Rs 420 crore to justify the current stock price!”
“Yeah, but we will earn Rs 400 crore in revenue very soon.”
“Really? That’s around 4x your current revenue!”
“Right! But didn’t I tell you that our future is bright?”
“Yeah, you’ve said it often! Is there anything more I should know about your business?”
“Yeah, the future is bright…and you can read it all in our 417-page offer document.”